We continue to talk about the stop loss order (start here). In the classical sense, this is an order insuring the open position of the trader, but those who are able to look a step further use it as a tool for earning. Or at least with his help they move away from the traps of large investors or market makers. Separate strategies can be built at the stop loss, one of which we are ready to share with you.
Stop Loss – a warrant that helps earn
Stop loss is considered a safety order, but for professionals it is also a tool for getting money from less experienced traders. In brief, we recall the basic rules of its setting:
- Avoid placing stops at obvious levels. You can hardly influence the direction of the price, while large investors by their capital will give the price to the most obvious levels, where the stops will work;
- lay down the risks of slippage of stops, pay attention to such a tool as trailing stop. You will need a VPS server for it, but it conveniently insures risks;
- Check out the broker’s trading terms. Often in the offer there are interesting nuances that can drastically affect the construction of the risk management system.
In practical terms, stop loss means a reverse trade, provided that there is an appropriate counterparty to it. In other words, if theoretically all traders made bids to buy, reinsuring themselves with stops, but suddenly Black Monday would have come, then the stops would simply not have worked due to the absence of counterparties. Fortunately, this is rare, because beginner traders do not attach any importance to this and place stops on a long position at or below the support level. But also placed here and limit orders in the expectation that the price will test the level of support and bounce upward from him.
In most cases, price fluctuations on long timeframes (from H1 and higher) will contain more stop loss orders than on short ones. On an hourly chart, the inaccessible point will be longer out of reach and therefore more visible to traders than on a chart in 5 minutes. That is, for longer periods, the levels of resistance and support are better seen, and traders have more time to navigate. And the second caveat: the more vertical the trend, the stronger it is, the more stops there will be and the bigger the positions will be, but the greater the likelihood of slippage.
Suppose the price goes down to the support level. According to the logic of novice traders, there should be a rebound, because the stop loss is slightly lower. By the time we reach the support level, we have the following picture:
- below are the stop loss orders of average traders;
- price breaks through the level by drawing a small inertial correction.
Theoretically, in this situation, it seems logical to open a long position that will be satisfied at the expense of stops set by beginners. But then traders, who make bets on short positions, enter the “game”, trying to inject prices into the market and close the positions of those who, at the support level, decided to open long positions as much as possible. This situation is called “the struggle of the bulls and bears.” At this moment, the price moves not so much under the influence of fundamental factors, as under the pressure of big capital, trying to roll each other’s positions.
From this situation we make the following conclusions:
- You should not open a long position with a short stop immediately after passing the support level (the same condition for the resistance level). There are a lot of stops at the bottom, which large investors will try to hook. Do not get involved in the struggle of stronger (wealthy) traders;
- after the breakdown of the support level, the price will go a little further, tearing down the feet. And at that moment, when the price movement slows down, that is, most of the orders are satisfied and the market becomes saturated, you can open a long position with a short stop. True, if the risk is that the downward trend will be major, but the position will be insured.
Stop Loss order is a good tool for cutting the positions of traders acting intuitively. Short stops are not always effective and the risk of long stops is justified. Do not be the majority – look at a step forward and earn with FxCash!